Abercrombie & Fitch Co

NYSE:ANF

Earnings Call Transcript 2019-Q1

[Operator]

Good day everyone, welcome to the Abercrombie & Fitch First Quarter Fiscal Year 2019 Earnings Call. Today’s conference is being recorded. [Operator Instructions]

At this time, I'd like to turn the conference over to Pam Quintiliano. Please go ahead.

[Pam Quintiliano, Investor Relations]

Thank you. Good morning and welcome to our first quarter 2019 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our first quarter earnings release, which is available on our website at corporate.abercrombie.com under the Investors section. Also available on our website is an investor presentation.

Please keep in mind that any forward-looking statements made on the call are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause the actual results to differ materially from the expectations and assumptions we mention today.

A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and the reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning.

With that, I will turn the call over to Fran.

[Fran Horowitz, Chief Executive Officer]

Thanks, Pam. Good morning, everyone, and thank you for joining us today to discuss our first quarter results. Throughout the quarter, we remained focused on our core customer and executing against our strategic initiative. This resulted in a solid start to the second full-year of our growing while transforming phase. In the first quarter, we grew the topline, we posted our seventh consecutive quarter of positive comparable sales. Abercrombie rebounded from Q4 with return to positive comps, while Hollister achieved its tenth consecutive quarter of positive comp.

We held this profit rate flat to last year. We had operating expense leverage and we delivered a 130 basis points of adjusted operating loss margin improvement and a net loss reduction. We continue to make progress on the transformation initiatives that’s outlined at our April 2018 Investor Day, optimizing our store network, enhancing our digital and omnichannel capabilities, increasing the speed and efficiency throughout our concept-to-customer product lifecycle and improving our customer engagement through our loyalty programs and marketing optimization.

Importantly, we remain on track across all four initiatives and following my discussion on Q1 results, I had exciting developments to share on global store network optimization. So, let’s discuss our first quarter. The brands have become increasingly differentiated than their products, voice, and experience. We continue to interpret product trends for each perspective target audience. What is increasingly clear though is that the customer demand's newness and when we deliver that they respond.

At Hollister, we had a plus 2% comp on top of a plus 6% last year. On the guy side, bottoms remain strong, especially jeans and pants, while fleece, tops, wovens, and outerwear were also solid. Guys achieved several records, including its highest ever first quarter sales in jeans, pants, outerwear and sweaters. Girls also experienced strength in outerwear and bottoms, with pants and shorts and skirts resonating.

We had record first quarter sales in pants and outerwear, as well as two of our must grow categories, swim and Gilly Hicks. Our Hollister marketing campaign serves the key complement to our products and brand conditioning. We just wrapped up our high school nation tour, but we had active in person dialogue with over 100,000 teens. On the digital side, Hollister had its five most engaged Instagram post of all time in the first quarter, including two from our slim collective.

The collection had a total reach of approximately 22 million people and total campaigns likes, comments, and shares are up approximately 300% from last year. At Abercrombie, comps returned to positive territory. We posted the first 1% comp on top of a plus 3% last year. The story here is about the progress we made in women’s.

Last quarter, Abercrombie comps were negative on the men’s and women’s tops and dresses. The teams quickly identified the opportunities and took advantage of our agile supply chain to update spring deliveries wherever possible.

During the first quarter, we provided newness in tops and dresses. Both categories registered a significant trend change with dresses recording its highest first quarter sales ever. In addition to tops and dresses, women’s bottoms was another highlight. Jeans shorts and skirts all performed well and pants posted its best first quarter sales in our company history.

I’m excited about the direction of our women’s business is heading. We are listening and responding to our customer and look forward to building on recent successes. I’ve spent a lot of time talking about women, but men’s have several highlights as well with strength in knits, joggers, and outerwear.

Our Abercrombie marketing team is involving our updated digital campaign will speak directly to our target mid-20s customer and their lifestyle. We have been highlighting our most fashion forward product and we are seeing results of year-over-year growth in traffic.

Our recent Fierce relaunch is a great example of our new integrated approach to marketing. The campaign has garnered over 300 million media impressions since its February introduction. While Scarce has always been popular, after the relaunch it had its best comp in over five years with about half of recent identified purchases coming from customers that we believe are new to the brand, which is very exciting.

Shifting gears to our transformation initiative, in the first quarter we built on the progress we made in 2018 and hit the ground running for the second full year of our growing while transforming phase. Thus far, a critical part of our transformation has been the optimization of our global store network, opportunistic closures, rightsizes, remodels, and select openings.

Though I’ve said it before, it is worth repeating, stores matter.

In this increasingly omnichannel world, the customer continues to value the ability to shop across channels and we remain focused on providing the most brand appropriate experiences whenever, wherever, and however they choose to engage with us.

Global store optimization is a key component of our ongoing operating margin expansion story and critical to achieving our previously stated fiscal 2020 goal. We ended fiscal 2018 with 861 stores across brands of which 90 are considered flagship. We have and continue to be focused on reducing our alliance on large format stores and transitioning to smaller, more omnichannel spaces in the best locations that cater to both local and tourist customers.

In line with that strategy, earlier today, we announced our plans to close three additional flagships. Hollister SoHo in the second quarter of fiscal 2019, Milan A&F by the end of fiscal 2019, Fukuoka A&F in the back half of fiscal 2020. But including the recent A&F Copenhagen closure this March and the Pedder Street, Hong Kong A&F closure in 2017 this will bring our total recent flagship closure count to 5, and takes it over 140,000 square feet of real estate that had below company average productivity. By excluding the recent announced closures there are 15 global flagships.

Looking ahead, we do expect additional closures through a combination of natural lease expirations, the exercise of pickup clauses and negotiation with our landlords. These actions ongoing, as well as the ongoing recent editioning of our fleet keep us on track for our long-term 2020 targets.

I want to end the conversation of real estate with one final thought. While I’m extremely proud of the over $1 billion in digital sales that we achieved in fiscal 2018, we are a modern omnichannel retailer. In this age, we’re seeing like every headline references a retail apocalypse, we continue to invest in our global store base. We have solid partnerships with our landlords and that's because we are one of the few retailers that remain committed to opening and remodeling stores. That has not changed.

We remain on track to provide approximately 85 new experiences for our customer this year, and are committed to finding additional opportunities that are aligned with our strategy. Beyond global store optimization, we also made progress on our remaining three transformation initiatives.

Our teams are highly focused on building our digital and omnichannel capabilities, increasing our efficiency and speed to market through our concept to customer product life-cycle and improving our customer engagement through our loyalty programs in marketing optimization.

Digital grew to 30% of revenues, compared to 27% last year with broad-based strength across the Hollister and combined Abercrombie brand. As we continue to evolve with our customer, we saw ongoing double-digit growth in our purchase online pickup in-store.

Within our efficiency and speed to marketing initiative, we continue to fine tune our lead time and find ways to expand our chase capabilities. While this focus has been unwavering, we’ve added more tools to our arsenal with the recent rollout of markdown and size optimization.

Lastly, our improving customer engagements, the growth of our loyalty programs has enabled us to have a customer identification rate of approximately 80% more than double from where we first introduced loyalty in Q1 2016. A critical next stage of our customer engagement initiative is to leveraged this data to better personalize the experience for each of our customers, and we recently launched key investments into systems and tools to help bring this to life.

Before I turn over to Scott, I want to give an update on a couple of current events in our industry. This burns to the potential tariffs on China stores to apparel. Over the past several years, we have been proactively reducing our dependence on China. We have long-standing partners in the region and they too have been shifting production out of China. These relationships provide us with flexibility as we continue to maintain active and open dialogues with our vendor partners.

As a reminder, roughly 25% of merchandise received for source in China and imported to the U.S. in fiscal 2018 and we plan to be below 20% this year. In addition to the China tariff, we’re also closely monitoring the retail landscape. In the U.S., post Easter traffic trends of the malls have been challenging.

In Europe, the macro situation remains in flux. And in Asia, we have a looming trade war. So, where does that leave us. We have not been immune to the more traffic trends seen post Easter. We believe that the U.S. consumer, which makes up the majority of our sales remains healthy.

Our traffic is tracked above the mall average, but we do not operate in the puddle. We anticipate a competitive environment and we have plans in place to read and react as necessary throughout the summer selling season. Whatever the environment, I am confident in our ability to execute and I’m excited about our summer assortments, which build on the newness in silhouette, fabric and details that our customers responded so favorably to in the first quarter.

In conclusion, our hard work is paying off. This is evidenced by our first quarter results, which build on recent momentum and provided additional support for our growing while transforming phase. With a stronger U.S. consumer backdrop, consumer backdrop, Kristin Scott and her team are providing differentiated product that is resonating across brands and effective relevant marketing campaign, I am excited about the future. Our flagship updated is yet another series of important step that keeps us on track to achieve our fiscal 2020 operating margin target.

And with that, I’m going to turn the call over to Scott.

[Scott Lipesky, Chief Financial Officer]

Thanks, Fran. I will kick it off with a discussion of our first quarter results. From there I’ll touch on the impact of our flagship and lease accounting updates before ending with our outlook.

Turning to the first quarter. Net sales of $734 million were up slightly to last year. Results reflected a $16 million adverse impact from changes in foreign currency. Comps came in at plus 1 on top of the plus 5 last year, marking our seventh consecutive quarter of positive comparable sales.

Consistent with the last several quarters, positive cross-channel traffic was the key driver of our comp growth with the customer continuing to respond when to our product and to our compelling branded marketing campaign.

At Hollister, we posted a plus 2 comp on top of a plus 6 last year, while Abercrombie returned to positive territory with a plus 1 comp on top of the plus 3 the last year. By geography, we had come sales of plus 4 in the U.S. with both Hollister and Abercrombie contributing to the result.

International comps were negative 4%. Europe experienced sequential comp improvement in the fourth quarter, while Asia weakened. We attribute a portion of our Asia weakness to internal missteps, including product acceptance of key categories, as well as not taking advantage of certain selling events in the region.

We continue to have an opportunity to get closer to our Asia and European customers and we look forward to building out our playbooks in these regions in fiscal 2019 and beyond. Our gross profit rate of 60.5% was flat to last year as we cleared through the majority of underperforming women's tops and dresses at Abercrombie. The year-over-year change reflects lower AUR, which was offset by reduced AUC.

I'll cover the rest of our results for the quarter on an adjusted non-GAAP basis. Adjusted operating expense, excluding other operating income was $472 million, down 2% from last year, which was better than our expectation coming into the quarter and resolving in a 160 basis points of leverage over last year.

The decrease in operating expense, compared to last year was primarily due to the impact from changes in foreign currency rates, decreased compensation expense, and a reduction in depreciation on store and IT assets. This was partially offset by volume-related expenses from higher digital net sales.

There were no excluded items in Q1 this year. As a reminder, in our first quarter 2018 results, approximately $6 million of pretax charges related to certain legal matters were excluded. Other operating income was down $2 million, compared to last year, contributing 30 basis points of deleverage.

Our adjusted operating loss was $27 million, compared to a loss of $37 million last year and included a $2 million adverse impact from changes in foreign currency. Adjusted operating loss margin improved 130 basis points, compared to last year. The adjusted effective tax rate for the quarter was 34%, which on a pre-tax loss was slightly better than our mid-20 guidance reflecting benefits related to stock-based compensation awards exercised in the quarter and changes in certain valuation allowances.

Adjusted net loss per diluted share was $0.29, compared to a loss of $0.56 last year and included the adverse impact from changes in foreign currency of approximately $0.02. We ended the quarter with total inventories of approximately 7% to last year. Of the increase, approximately 5 percentage points was driven by higher in transit inventory and lower inventory reserves.

We plan to end the second quarter with inventory up mid-single digits, reflecting an increase in forecasted in transit inventory flows, due to updates to our August and September floorset strategy, compared to the last year.

Before turning to our outlook, I'm going to take a few minutes to go through some new items. I’ll start with today's flagship news, and the resulting impact on our P&L. As Fran mentioned, we have identified three flagship locations that will be closing over fiscal 2019 and 2020.

We also closed our Copenhagen Abercrombie flagship this past March. As a reference, these four locations combined represented under 1% of our fiscal 2018 revenues. So, the impact on top line going forward is minimal. In the second quarter, we expect to take net lease-related charges of approximately $45 million, due to the SoHo and Fukuoka closures.

We expect to have more flagship closure announcements in the future. Each store situation is unique and therefore the top line and expense commentary provided today should not be extrapolated to our other flagships. Given the delicate nature of exit negotiations, we are not prepared to discuss details of potential future closures at this time.

Next up is lease accounting. At the beginning of this fiscal year, we adopted the new lease accounting standard. We are using the modified retrospective transition method and have chosen not to restate prior periods. Upon adoption of the new lease standard on February 3, our total assets and total liabilities each increased by approximately $1.2 billion. These increases primarily reflect the recognition of right-of-use assets and liabilities.

In addition, we also recognized a cumulative adjustment decreasing the opening balance of retained earnings of approximately $75 million. The majority of this adjustment was related to an initial impairment of right-of-use assets or stores where the carrying value of assets was not recoverable.

I’ll finish up with our outlook for the full-year and the second quarter. Regarding fiscal 2019, we expect net sales growth of 2% to 4%, driven by comparable sales of net new store contribution, partially offset by an adverse impact of changes in foreign currency exchange rates. We now expect the adverse impact of FX to be $30 million, up from our prior expectations of $15 million. Comparable sales to be up in the low-single-digit range.

Gross profit rate to be up slightly for the 2018 rate of 50.2% with higher average unit retail, net of adverse foreign currency impacts to be partially offset by higher average unit cost. Operating expense, excluding other operating income to be up 4% to 5% from fiscal 2018 adjusted non-GAAP operating expense versus our prior outlook for a 2% rise. This change reflects approximately $45 million or 220 basis points in net lease-related charges, due to the SoHo and Fukuoka flagship closures.

And finally, our full-year tax rate to be in the mid-20 versus our prior mid-to-upper [20s expectations]. We are closely monitoring China trade talks and our outlook at this time assumes only current tariffs in place. Regarding our second quarter, our outlook assumes net sales to be flat to up 2% from last year, reflecting a $10 million adverse impact from FX.

Comp sales to be approximately flat. Gross profit rate to be down approximately 100 basis points from last year's 60.2% rate, while expectations for continued FX pressure and our heightened promotional environment. Operating expense, excluding other operating income to be up approximately 10% from 2018 adjusted operating expense of $498 million, including net lease-related charges of approximately $45 million. If not for the $45 million, we would have expected operating expense to be flat to up 1%, and an effective tax rate in the mid-20s.

With that, let me turn the call back over to Fran.

[Fran Horowitz, Chief Executive Officer]

Thank you, Scott. I’d like to thank our global team of associates for their contributions. In Q1, we continue to make progress towards our fiscal 2020 financial goals and this could not have been done without all of you. I’d also like to thank Joanne Crevoiserat. Joanne joined us about five years ago as the CFO and promoted to COO in early 2017. She is my great partner, as we stabilized the business and moved into our growing while transforming phase. During her time here, she's built a strong team and I’m confident that we have the right talent in place to build on her our important work. We wish her the best of luck on her future endeavors.

[Pam Quintiliano, Investor Relations]

Thanks, Fran. That concludes our prepared comments. We will now be happy to take your questions. As a reminder, please limit yourself to one question so that we can speak to as many of you as possible. Thank you.

[Operator]

Thank you, ma’am. [Operator Instructions] We will take our first call from Omar Saad from Evercore ISI. Please go-ahead sir.

[Omar Saad, Evercore ISI]

Hi. Thanks for taking my question. I wanted to understand the higher OpEx planned in the closing of the flagship, could you give us more detail around that? How many you’re closing, what the decision process looks like? How big of a factor is that? Is that the key factor driving the higher SG&A line, and the lack of margin outside from that side? Thanks.

[Scott Lipesky, Chief Financial Officer]

Hi Omar, it’s Scott. Yes, that is the key driver. The flagships, the $45 million charge that we talk about for Q2 is the driver of the change in the OpEx outlook for the full-year. That added about 220 basis points to our – or up approximately 2%. So, just putting us in that range of [4 to 5] that we laid out. We are closing three stores and we’ve announced the closure of three stores. They will close within the 2019 and 2020 period. This is a really nice step forward for the company.

We’ve been on this path for a while now and so it’s nice to come to you with some nice progress in this area and we look forward to looking to reposition within some of these markets and really move to these smaller, more intimate omni-channel space as we move forward. So, we also mentioned that there will be additional closures coming in the future and we look forward to bringing news in the future.

[Omar Saad, Evercore ISI]

Have these flagships been net drags and should we expect a lift as you work through them on the P&L?

[Scott Lipesky, Chief Financial Officer]

In total, the flagship business, the global flagship business is a drag on the top line and a drag on the bottom line. So, while each one in itself is small, you know in the future over the many years it’s going to take us to get out of these things, they’ll add up. We mentioned that the four that we’re closing were less than 1% of our sales in 2018. So, like I said, the incremental improvement is what we’re expecting over the years. There’s not a silver bullet whenever it comes to these flagships by closing one or two or three that’s going to save the day, but it’s just going to be a methodical approach to get through these things over the years.

[Omar Saad, Evercore ISI]

Thanks, Scott.

[Operator]

Next, we’ll go to Paul Lejuez with Citi.

[Paul Lejuez, Citi]

Hi. Thanks for taking my question. Just given the flat comp guidance in the second quarter and some commentary on the promotional environment, could you just elaborate how much of that is driven by the competitive set and how much of that is related to inventory level coming out of the first quarter? Thank you.

[Fran Horowitz, Chief Executive Officer]

So, I’ll take the first half of that question. So, we’re excited about our business for the first quarter. We comp the comp. We had our seventh consecutive quarter of positive comps for the company, tenth for Hollister, and exciting that we took Abercrombie from negative to positive from Q4 to Q1. The consumers voted on our assortment. We had some exciting record this quarter as well. We went from best quarter in Swim for Hollister Girls to best quarter in Hollister Guys for outerwear.

So, balance assortments that our consumer is voting on. We believe that what we’ve learned from this quarter will help us drive our business for the second quarter. With that said, we have seen a little bit of weakness as we are headed into the quarter with mall traffic, our mall traffic actually continues to trend about the total mall traffic. So, we are still very confident in our assortments for the second quarter.

[Scott Lipesky, Chief Financial Officer]

From an inventory perspective we're comfortable with the inventory coming in, the print looks a little high plus 7, but that is a couple of big items driving that. So, we have about 5 percentage points that are coming from in transit and some lower reserves year-over-year. So, we are comfortable with the inventory position. As Fran mentioned, we’re acknowledging what’s happening around us. It’s been a slow start in the mall in the U.S. to start May. And so, our gross margin guidance for Q2 of down 100 basis points, it gives us that flexibility to be competitive if the promotional environment heats up in the quarter.

[Paul Lejuez, Citi]

Great. Thank you.

[Operator]

Next, we’ll go to Kate Fitzsimons with RBC Capital Markets.

[Kate Fitzsimons, RBC Capital Markets]

Yes, hi, good morning. I guess just expanding on the gross margin commentary, it sounds like you are still planning for AURs to be up into the back half to reach that slightly up gross margin guidance, could you just speak to what gives you the confidence there on that back half improvement? And then secondly, the international business was down 4% from down 2% last quarter, you called out some issues may be in Asia, but can you just elaborate on some more regional commentary, that would be helpful as well? Thank you.

[Fran Horowitz, Chief Executive Officer]

Okay, good. Our business is and always has been back half rated. Obviously, back to school and holiday are very important times for us. And from a product perspective, we are staying very close to our customer, we're learning every day. I think that’s quite evident in the change we saw from Q4 to Q1 in our Abercrombie women's dress business, which went from negative 2 record-setting in the quarter.

So, as we continue to focus on the consumer, continue to focus on the product that in conjunction with our marketing campaigns that continue to show that the integrated campaigns are resonating with our consumer really gives us the confidence as we head into the back half.

[Scott Lipesky, Chief Financial Officer]

Yes. I’ll pick up the international side. So, a little bit of a mix bag here internationally. In Europe, we did see sequential improvement off of Q4. The Hollister trend was very consistent with Q4 and then the A&F business which is primarily our flagship business picked up a little bit versus Q4, you know really tracking what happened in the U.S. when we see that women's product turnaround within the quarter.

We continue to focus on transitioning away from those flagship's and based on our announcement today, as well as a couple of stores that we opened in Q4, and we continue to keep an eye on the macro environment in Europe. It is certainly dynamic and tracking Brexits and the European elections and everything else that’s happening through the key countries in Western Europe. So, definitely keeping an eye there.

From an Asia perspective, we did see sequential weakness in Q4. We expected some of this quarter-over-quarter as the Chinese New Year shifted between the month of January and February, but we did have some self-inflicted issues here. We didn’t maximize the team all event in February. And as mentioned, we saw some product acceptance issues in some of our products. So, that was really the key drivers that we saw in Asia.

We’re keeping our eyes there on the looming trade war. Everyone is keeping an eye on that it’s in the headlines every day. So, again, tracking that and how that’s impacting our future customer – our current and future customer. If we take a step back from the international business, we still feel that we have a great long-term opportunity here. We are under penetrated in our key markets across Europe and in China and so we’re continuing to – what we call export our playbooks.

We have a great team in place here in the U.S. that’s digging into the customer. It's aligning our product invoicing and experience with our customer. And we're building out those teams in Europe and in Asia. And we’re optimistic that as we get those teams and processes in place that we're going to be able to attack that growth long-term.

[Kate Fitzsimons, RBC Capital Markets]

Great. Best of luck for the second quarter.

[Operator]

Will go next to Matthew Boss with J.P. Morgan.

[Steve Zaccone, J.P. Morgan]

Great thanks. This is Steve Zaccone for Matt today. Thanks for taking our question. Within the second quarter guidance, can you just elaborate a little bit more on comp expectation by brand, is one brand seeing more softness than the other quarter to date? And then as we look to the second half of the year, can you just speak to the drivers of expected comp improvement, do you still see comp up low single digits for the full-year?

[Scott Lipesky, Chief Financial Officer]

Yes, I’ll grab the first part. For Q2, we don't go into a brand basis. Our goal is to manage the total. I would say that we’ve all seen the traffic reports that have come out over the last three weeks and both of our brands exist primarily in malls, so neither brand would be immune to the traffic that’s coming into the mall, but we’re optimistic as we get into the peak summer selling period that all the learnings we have from the spring season in the peak selling periods of Easter and Spring break will translate into the summer and that’s what’s baked into our flat for Q2.

[Fran Horowitz, Chief Executive Officer]

Hi Steve, it’s Fran. Regards to the second half of the question. So, as we head into the back half, just to reiterate, we do expect continued sales growth. The house momentum has continued, we are pleased with our results in the first quarter, particularly our North America business is an continues to be strong. We have stabilized Abercrombie. We saw nice shift from Q4 to Q1 by identifying those product opportunities. We believe that we stay close to the customer. We’ll continue to make sure products resonate.

We talked a bit about our supply chain and the agility in our supply chain that was clearly demonstrated by the Q1 change tops and dresses for our brands. And again, we’ve also made some transformation initiative investments. We talked about that a little bit earlier today. So, for example, marketing investments, we’re working to personalization. We’ll start to see that kick-off in the back half. Markdown and size optimization are also tools that we’ve embedded. So, we have a lot of momentum heading into the back half of the year.

[Steve Zaccone, J.P. Morgan]

Great. Thanks for that detail. And just one question on the flagship. With the 15 flagships remaining, is there any way to contextualize how much these stores account for in terms of revenue or maybe how much they are in over a drag to the overall operating margin for the company?

[Scott Lipesky, Chief Financial Officer]

Steve, we're not going to provide that detail at this point. I would say, in total they are dragged to comps and profitability, it is going to take us a while to get out of this thing. We’ve been clear on that and so year-by-year we’re looking to pick these things of one-by-one and long-term we will have some of these flagships longer-term because they are in the right place and the right shopping areas within the cities that we’re in, but each store has its own story and we're going to work through them month-after-month, year-after-year.

[Steve Zaccone, J.P. Morgan]

Yes, I understood. Thanks very much.

[Operator]

Your next question comes from the line of Mark Altschwager with Baird.

[Mark Altschwager, Baird]

Hi, good morning. Thanks for taking my question. Exciting to see the return to positive comps at Abercrombie, great to hear the turn in women's, I’m wondering I mean, do you feel that you hit a turning point there given that each of your comparison through the year, how confident are you that ANF can maintain positive comps from here?

[Fran Horowitz, Chief Executive Officer]

Hi, Mark it's Fran. The comps for both brands are built into our outlook. I’m pleased, obviously and have confidence in the assortments and what the team has been able to do in the short-term. Kristin and here impact on ANF team is clearly resonating. Our playbook is working. We talk a lot about talk a lot about product voice and experience coming together. So, as long as we stay in that past it’s all reflected in our outlook.

[Mark Altschwager, Baird]

Got it. And if I could quickly follow up on SG&A, I think the outlook is unchanged, excluding the lease charges, but presumably there would be some benefit on the occupancy cost savings given the flagship closures. So, I’m wondering if you could discuss any other changes to your SG&A plans that are maybe offsetting lower occupancy costs? You know any callout on the marketing or distribution projects, any changes there? Thank you.

[Scott Lipesky, Chief Financial Officer]

No change on the OpEx outlook for the year. We would pick up a little bit of occupancy on the SoHo store that will close at the end of Q2. The Milan closure is pretty much at year-end, so there’s not a pick up there. And then the Fukuoka closure is out in 2020. So, it's really coming down to the SoHo where we pick up a little bit of OpEx and we lose a little bit of the topline, so not materially impact to the OpEx for the back half.

[Mark Altschwager, Baird]

Great, best of luck.

[Scott Lipesky, Chief Financial Officer]

Thanks.

[Operator]

Now, we’ll go to Susan Anderson with B. Riley FBR.

[Susan Anderson, B. Riley FBR]

Hi, good morning and thanks for taking my question. I was wondering if you could maybe just give some thoughts – you talked about I think still feeling confident about achieving the 2020 targets, so maybe if you could just kind of talk about the path from here to there, particularly I guess in terms of the EBIT margin from 2017 levels and I think you laid out a $1.5 billion opportunity in Europe and China, and just curious if maybe that’s changed at all given the macro events out there? Thanks.

[Scott Lipesky, Chief Financial Officer]

The path to 2020 hasn't changed and we've been pretty consistent since the 2018 Investor Day. It’s about topline growth, some modest gross margin expansion and then OpEx leverage to get us there. 2018 was a good first step. We picked up a 100 basis points of the 290 or so basis point that we need, and that’s really the path that we’re on. Q1 was another step forward. We saw leverage – we saw expansion on the operating margin line at the bottom. You know as we think about the past from here to the remaining of 2020, we remain confident that we’re on that track. It’s about growing the topline; it’s about leveraging the expenses and getting some gross margin in the middle.

The transformation initiatives that we’ve talked about are so important to get us there. Each one of the four that we talk about each quarter are all about driving one of those levers to get us to that formula. On the $1.5 billion opportunity in Europe and Asia, that's truly a longer-term aspiration. It wasn't baked in that we needed that $1.5 billion to get to our 2020 target. So, while we expand our store count slowly in our digital business in the European and Asian markets, it’s not the $1.5 billion that we need for the 2020, but again, a very optimistic long-term that we can further penetrate those markets.

[Susan Anderson, B. Riley FBR]

Great, that’s really helpful. And maybe if you could just touch a little bit more on inventory, it sounds like the higher maturity is mainly just in transit. I guess are there any pockets of higher inventory globally though that you're seeing? Or is it main – or is it really just a higher in-transit? Thanks.

[Scott Lipesky, Chief Financial Officer]

Yes. It's really just those two pieces that we called out. Remain comfortable with the inventory levels. The gross margin outlook that we have for Q2 is really about the competitive landscape and the FX and not an inventory forced gross margin outlook.

[Susan Anderson, B. Riley FBR]

Great, thanks so much. Good luck next quarter.

[Fran Horowitz, Chief Executive Officer]

Thanks.

[Operator]

We’ll next go to Janet Kloppenburg with JJK Research.

[Janet Kloppenburg, JJK Research]

Good morning everybody. Just a couple of questions, Fran, first of all, if you could give us a little bit more clarity on current transit, it sounds like someone of your prior answers that maybe Hollister is okay, but there’s been slow down at ANF, and we’ve heard more about the weather being the culprit as opposed to the competitive environment. So, maybe you could just talk a little bit about that and what’s embedded in your guidance. In other words, do you think that as weather improves that the comp will improve as we go through the quarter? Just a little bit more clarity on this slow down and the outlook for the gross margins to be of more pressure than we had expected? And also, on the tariff outlook, if tariff – higher tariffs do become a reality then should we expect some adjustment on the current gross margin outlook? And just for Scott, on the $45 million real estate charge, I assume that it sounds like a GAAP charge, so do you want us to be modelling on a GAAP basis or a non-GAAP basis for the second quarter? Thank you.

[Scott Lipesky, Chief Financial Officer]

I’ll grab the last part of that, multi-part question first. The $45 million is a GAAP charge. I would say its GAAP and non-GAAP. It’s not going to be excluded from our results, so you should model that in to the results for the year and the quarter.

[Janet Kloppenburg, JJK Research]

So, it’s going to be in a non-GAAP P&L?

[Scott Lipesky, Chief Financial Officer]

That is correct.

[Janet Kloppenburg, JJK Research]

Okay.

[Scott Lipesky, Chief Financial Officer]

Yes. Because it’s a lease related cash charge it will be in the results. It’s very similar. If you look back to 2016 for us, the way we treated Pedder Street, so it’s something that we’ll continue callout, but it will be in our results.

[Janet Kloppenburg, JJK Research]

Okay, thank you.

[Scott Lipesky, Chief Financial Officer]

Yes.

[Fran Horowitz, Chief Executive Officer]

So, going back up to the top, we do not give specific brand trend, so I'm not sure you've heard it, but what I can tell you is that again to reiterate, you know, very pleased with our first quarter performance. Both brands were positive, both brands comps-to-comp, definitely pleased with the turn that we saw in ANF from negative to positive. The specificity on whether, you know, its and interesting question everybody asks. You know we had two records in the first quarter, one was guys outerwear and the other was girl’s swimwear.

It is very important to the teams to keep balance in their assortments. Balance is the word I use with them all the time, it’s actually my favorite word, and staying closer to customer and keeping a balanced assortment give us the confident in our outlook that we've already expressed earlier today. I think there is one more question.

[Scott Lipesky, Chief Financial Officer]

Yes, on tariffs – yes, on tariffs, yes, nothing baked into our outlook. You know we’re still dealing in the world of hypothetical here. We remain very engaged with our sourcing partners. We actually just had a vendor conference in Vietnam recently where we sat down with a hundred of our closest friends from a vendor perspective, and obviously this was a topic of consideration, and we have a playbook in place. If the hypothetical becomes reality, we continue to engage with those landowners or those vendors and we’ll have more to say then.

[Janet Kloppenburg, JJK Research]

Thank you.

[Operator]

Alright. We’ll next go to Dylan Carden with William Blair.

[Dylan Carden, William Blair]

Thank you very much. Just curious if you could unpack some of the operational efficiencies and where we are that you’ve kind of built into the model here over the last couple years, dynamic pricing, European merchandise team independence, you know, collective bargaining on fulfillment, anything to add there as far as sort of how much more and how quickly that sort of impacted the Abercrombie recovery and sort of the stability that that lends to the overall model would be appreciated? Lead times things like that will be great.

[Scott Lipesky, Chief Financial Officer]

I’ll kick it off with some of the more expense side of it. The path we've been on around store occupancy, I’d say is the biggest callouts. This is a multi-year journey, so we’ve been trying to grow sales and by taking out square – while taking out square footage, we've been successful at that over the past couple of years, and that’s really the path that we’re going to stay on. We have a couple of tools in our toolbox here. One is store closures and that’s a path we’ve been on. But another one is rightsizing of our store base.

A great stat that we like to talk about internally is, you know, over the last couple of years, we've right-sized or downsized over 30 stores and we’ve taken out over 30% of the square footage of those stores and held the topline. So, these are just little nuances of productivity that are going to add up to our longer-term targets. And unfortunately, it takes us a while to get there, but it’s a path we've been on and a path we’re going to stay on.

Rolling out new prototypes is also something that helps our business. These are smaller stores, more efficient towards more Omni-channel based stores, and they’ve been more productive that our baseline stores. So, that’s kind of the store occupancy in a nutshell and that’s been a big structural change for us over the last couple of years.

[Fran Horowitz, Chief Executive Officer]

And on the lead time, Dylan, we have a very seasoned sourcing team and we have strong relationship with our vendor community. In fact, we just held a vendor conference in Vietnam a few weeks ago talking about strategy and opportunities for us to go forward. We had taken out several weeks in our concept-to-customer lead times over the past few years.

We continue to stay focused on that.

The teams hold open to buy each week and they respond to the business. Just as one example, you know, our fastest category today is cut and sewn knit. We can turn knit domestically in four to six weeks in that particular category, but it does differ by category and by region, but we’ve made a lot of progress on lead time. We’re excited about what's happening with our sourcing team.

[Scott Lipesky, Chief Financial Officer]

I’ll just circle back. You did mention dynamic pricing. In the Investor Day in 2018, we laid out that we have a big opportunity to be smarter with data and analytics and how we embed that into our business. The couple of tools that we talked about then were rolling out size and markdown optimization. It took us 2018 to get these programs in place. We’ve rolled them out at the start of Q2. So, the models will continue to live and learn as we go through Q2 and Q3, so we expect some benefits as we get into the back half of 2019 and to 2020.

The other one that we talked about today was investing in some personalization tools. So, this is the next phase of how we’re going to leverage that data from a loyalty perspective to better personalize, sorry, the customer experience on more of a one-on-one basis. So, these are key investments; they take a little bit of time; they take some organizational change, but we’re on track and those are going to be drivers of our topline we believe.

[Dylan Carden, William Blair]

Sorry Scott, second quarter of 2019 you rolled out the sort of data and analytics tool or…

[Scott Lipesky, Chief Financial Officer]

That is correct, yes. We were in implementation mode through 2018, and then, we went live in the being of Q2 here with markdown and size optimization.

[Dylan Carden, William Blair]

Thanks. And if I could just sneak a quick one in, just trying to square the omni-channel sort of capabilities being added to the smaller Abercrombie footprint, how does that work, and sort of what efficiencies are being built into to sort of make those more omni friendly?

[Scott Lipesky, Chief Financial Officer]

Within the stores so we – for Abercrombie specifically, we've been training this box from in the past, call it 8,000 to 10,000 square feet, and to more of a 5,000 to 6,000 square feet. Within the store itself, we put handheld devices in; we’ve updated the fitting room experience; we’ve put pop-ins, closets so purchase online, pick up in-store closets to make that a more efficient experience for the customer. We’re still in the early innings of rolling out that omni-channel experience and that’s a key focus of all of our brand teams and our store design teams to make sure that experience gets better and better as we go forward.

[Operator]

Your next question comes from the line of David Buckley with Bank of America.

[David Buckley, Bank of America]

Hi, thanks for taking my question. Just could you share inventory positioning by brand entering the second quarter? And then any commentary on foreign tourism trends you're seeing? Thank you.

[Scott Lipesky, Chief Financial Officer]

From a brand perspective, we’re comfortable across brands. We don't usually give that level of detail. On the tourism basis, we’ve talked about this for the last couple of quarters, and it's been a consistent story. The U.S. tourism has been soft. We expect it to remain soft based on where the currency levels are both within Europe and within South America. So, we – you know, we see this concentrated on the coasts, mainly East Coast from Europe, and then, down into Florida from South America and Europe.

So, those trends have continued. In light of that, we continue to have a very strong U.S. business with a plus 4 comp in Q1 on top of a plus 8 last year. So, in light of that tourism softness, we’re driving a nice solid U.S. business.

[Operator]

And next, we’ll go to Tiffany Kanaga with Deutsche Bank.

[Tiffany Kanaga, Deutsche Bank]

Hi, thanks for taking your question. You touched on it, but would you dig a little more into the drivers behind your second quarter expectation for gross margin down 100 bps breaking it down with color around currency impact? Additionally, would you discuss what kind of currency impact is folded into your gross margin full-year plan since we saw that 60-basis point [depression in 2016] when there was also about $30 million in currency headwind? You now considering the greater FX sales headwinds, but reiterated margin guidance, perhaps you could also elaborate a bit more around what might have bolstered your confidence in second half offsetting benefits? Thanks.

[Scott Lipesky, Chief Financial Officer]

Okay. I will try to unpack that. So, FX, yes, I’ll start with the topline here, so for the year, we’ve taken it from a $15 million adverse impact of $30 million. From a margin perspective, that will be a little bit of a hurt. We still see the majority of that coming in the front half. We had that in Q1 were it was about $16 million hurt on the topline and $10 million that where our outlook covers for Q2. So those are going to be a bit of the margin drag here in Q1 and Q2. For the back half, the currency year-over-year will be a little bit more stable. Those key European currencies where we have the majority of our business weakens pretty significantly in the back half of last year, so we’ll start to comp that.

So, that’s part of the reason why we have more confidence in the back half as we will lap some of that issue. For our Q2 specifically, two ways to unpack that 100-basis point down gross margin outlook. We will have some that FX hurt and I’ll call that 20-basis point, 30 basis points. The remaining is giving us the ability to operate in a competitive environment. So, while we see the soft start here in the U.S., if inventory starts to pileup across the industry, we expect people to get more promotional and more aggressive, and we’re going to be playing in that environment. So, that's why we have the outlook of down 100 for Q2.

[Fran Horowitz, Chief Executive Officer]

But from a confidence perspective, Tiffany, our consumer continues to react to newness. We saw lot of newness in Q1. A great example of that is the category that I call one-and-done for the female consumers, that’s rompers and jump suits. We had a very strong response to that. We are able to react to things like that and get back into them as we head into the back half of the year. Another opportunity is waist details and tie details.

So, our consumer is responding to fashion. She and he are responding to newness. With the agility of our supply chain that we just talked about a few minutes ago, we can respond to those in real time. And so, we continue to be focused on our assortment going forward and our consumer.

[Operator]

Alright. And we’ll take our last question from Marni Shapiro with Retail Tracker.

[Marni Shapiro, Retail Tracker]

Hey, guys. Actually, congratulations in what's been a very choppy environment. Stores do look really great. I have two quick ones. Since we’re in the public forum, would you guys give any insights around a pickup if there was any around the Memorial Day weekend? And then, Fran, if you could just talk about the marketing expenses for the second quarter, and I mean particularly, the back of the year? You’ve had very high social media engagement; you have 30% direct-to-consumer that's where your customer is gravitating. So, how should we think about your marketing spend to the back half of the year?

[Fran Horowitz, Chief Executive Officer]

Okay. So, first part of the question, on Memorial Day, you’re right, we can’t comment on inter-quarter. What I can tell you, though, is that the first few weeks of May are the smallest part of the quarter for us. We are prepared to see the majority of the quarter ahead of us and based on what we are seeing from our consumer in response to key categories that gain importance to the second quarter. That’s where we feel confident in our assortments.

I may let Scott talk specifically about the expense piece of it, but yes, we have had a very strong social engagement with our consumer. We intend to continue on that, excited about the plans that the team had in place for some of our campaigns in the back half, you know, building on things like our Fierce campaign, which we just came off which was very successful to your point, so lots of excitement there. And I’ll let Scott speak to the specific numbers.

[Scott Lipesky, Chief Financial Officer]

So, marketing will be a key area of investment for the back half. In 2018, we took a nice step-up for the year in terms of our marketing investments. We will continue to build on that for this year. It will be at a slightly lesser rate with that nice step we took last year. Within the marketing spend, though, one of our key transformation initiatives has been optimizing that spend.

So, our teams have done an amazing job putting tools in place and putting processes in place to make sure that we’re investing the dollars that we are spending in the right channels. So, what that has resulted in, as you mentioned, some strong social media engagements because we’re putting the money in the right places. So, even within a flat environment from a marketing expense perspective, we would expect our performance to be better because our teams are smarter and putting the money in right place.

[Marni Shapiro, Retail Tracker]

Right. Fantastic, best of luck guys.

[Fran Horowitz, Chief Executive Officer]

Thank you.

[Operator]

And it looks like there are no further questions at this time. So, I’d like to turn the call back over to Fran for any additional or closing remarks.

[Fran Horowitz, Chief Executive Officer]

Thank you. So, we are pleased with our first quarter performance and the progress on our transformation initiatives. I look forward to updating you further as the year progresses, and thank you for your continued interest and support.